THE OFFICE OF THE ASSISTANT SECRETARY OF DEFENSE
WASHINGTON, D.C. 20301-8000
14 October 1988
PRODUCTION AND
LOGISTICS
(L/EP)
DEFENSE ENERGY PROGRAM POLICY MEMORANDUM (DEPPM) 88-1
MEMORANDUM FOR DESIGNATED ENERGY OFFICIALS OF THE OFFICE OF THE
SECRETARY OF DEFENSE, ORGANIZATION OF THE JOINT
CHIEFS OF STAFF, MILITARY SERVICES, AND DEFENSE
AGENCIES
SUBJECT:
Defense Facilities Energy Selection
This memorandum provides updated policy guidance for the
selection of energy for Defense facilities and implements Senate
Armed Services Committee Report 99-331 and Title 10 U.S.C.,
Section 2690. DEPPMs 85-3 and 85-4 are hereby canceled.
Recent legislation has greatly increased flexibility in the
selection of energy for Defense facilities. Public Law 100-42,
signed on May 21, 1987, greatly reduced the constraints of the
Powerplant and Industrial Fuel Use Act, which specified the use
of coal and/or solid fuel in large powerplants and major fuel
burning installations.
Public Law 99-661, directed that the primary energy source
for any new or rehabilitated energy system constructed on lands
under the jurisdiction of the Military Departments shall be the
most life-cycle cost-effective alternative. The Act also
directed the Secretary of Defense to prescribe regulations for
the Services to implement that direction. The enclosed guidance
provides technical and management policy to be used in the
evaluation of all new or rehabilitated energy source alternatives
for Defense facilities worldwide. Addressees are requested to
furnish this office with copies of implementing direction within
120 days.
Enclosure
ENERGY SOURCE SELECTION AND APPLICATION CRITERIA
FOR DEFENSE FACILITIES
I. GENERAL POLICY: The primary energy source selected for all
new Defense facility uses (including major rehabilitation efforts
which provide an opportunity to evaluate energy alternatives)
shall be the lowest life-cycle cost (LCC) alternative which meets
the basic quantity, quality, and reliability requirements of the
mission supported within specific limits and guidelines imposed
by law.
Acquisition of a specific energy supply shall be through
the open, competitive procurement process wherever possible.
A.
CONVENTIONAL ENERGY SOURCES:
Public Law (P.L.) 100-42,
signed on May 21, 1987, repealed the section of the Powerplant
and Industrial Fuel Use Act which specified the use of coal or
solid fuel in plants over 100 MEGA BTU per hour input.
However,
a new electric power plant constructed on lands under the
jurisdiction of the Services may fall under the requirements of
Section 201 of P.L. 100-42 which states: "..no new electric
power plant may be constructed or operated as a base load
power plant without the capability to use coal or another
alternative fuel as a primary energy source."
Section 201 states that a power plant has this capability if
it: "(1) has sufficient inherent design characteristics to
permit the addition of equipment (including all necessary
pollution devices) necessary to render such electric power plant
capable of using coal or another alternate fuel as its primary
energy source; and (2) is not physically, structurally, or
technologically precluded from using coal or another alternate
fuel as its primary energy source."
The statute further states that this capability "...shall
not be interpreted to require any such powerplant to be
immediately able to use coal or another alternate fuel... on its
initial day of operation.” The owner or operator of any new base
load electric power plant which uses natural gas or petroleum as
its primary energy source must also comply with the Department of
Energy notification requirements of Section 201(d).
B. CONGRESSIONALLY DIRECTED COAL PROGRAM: The Fiscal Year
(FY) 1987 Defense Appropriations Act, P.L. 99-500 (Section 9099),
reiterated the continental United States (CONUS) coal use program
directed by P.L. 99-190 (Section 8110). The FY 1988 Defense
Appropriations Act repeated this direction. The goal of this
Congressionally directed program is to increase annual Defense
coal use by 1.6 million short tons by FY 1994 as compared with
FY 1985 usage. P.L. 99-500 added a "sub-target" to the program
to achieve an annual increase in the use of anthracite coal by
300,000 tons by 1994.
It is Defense policy to actively search
for opportunities to increase CONUS coal use to meet or exceed
these goals within the constraints of:
lowest LCC fuel selection
criteria; National, State, and local environmental restrict ions;
ENCLOSURE
private venture capital contracting viability; and continuing
availability of the administrative funds made available by
Section 8110, and made available for obligation until expended by
Section 9099.
C. NON-CONVENTIONAL ENERGY SOURCES: The use of non-conventional energy sources (solar, geothermal, wind, tidal, biomass,
refuse or refuse-derived fuel, waste oil and synthetic fuels) is
strongly encouraged, wherever LCC effective and commercially
viable.
Special care must be taken in the evaluation of possible
refuse or refuse-derived fuel alternatives. There may be
conflicting views on the environmental impact of such plants,
leading in extreme’ cases to litigation.
Defense personnel
responsible for such projects must make sure that contracts
clearly require that all applicable environmental laws and
regulations are adhered to.
Contracts for energy from privately-financed refuse-fired
facilities must contain terms and conditions which assure that
the contractor carries out all his environmental responsibilities.
As a minimum, these contracts shall contain provisions that the
design, and operation and maintenance program be reviewed and
certified as acceptable by an independent, qualified Professional
Engineer, prior to contract signature.
An annual review of the
quality of operation and maintenance of the plant shall be
required to be conducted by an independent, qualified
Professional Engineer and a report filed with the Defense
contracting officer, with remedies for unacceptable performance
specified in the contract. In addition, provision should be made
to periodically sample the waste streams into (particularly that
of the Defense installation) and out of the plant to permit
evaluation of compliance with environmental regulations.
II. ECONOMIC ANALYSIS : Energy related economic analysis
procedures are prescribed by the National Energy Conservation
Policy Act, 92 Stat., 3275, implemented by the National Bureau of
Standards (NBS) Handbook 135, “Life-Cycle Cost Manual.” In order
to determine the lowest LCC energy alternative, an economic
analysis from the perspective of cost to the Federal government
(in accordance with Senate Committee on Armed Services Report
99-331 which accompanied the National Defense Authorization Act
of FY 1987) shall be performed.
The economic analysis of both in-house and privately-funded
alternatives must be prepared using the following criteria in
addition to the procedures contained in NBS Handbook 135:
• The economic analysis of all the alternatives considered,
including maintenance of the status quo, if it is an
alternative, must be included as part of the decision
backup.
•
The Office of Management and Budget (OMB) Circular A-94
must be used to determine the LCC of each conventional
energy alternative proposed (see Section C. below for
specific rules applying to renewable energy alternatives).
•
All economic assumptions used to perform the evaluations
must be included with the respective alternative.
•
Sensitivity analyses, comparing the effects of changes in
initial investment, operating costs, etc., must be
included to enable reviewing officials to fully evaluate
how changes in assumptions affect the project’s viability.
•
If no private-sector or coal-fired power plant proposals
wereconsidered, an explanation must be attached stating
specifically why these alternatives were not included in
the evaluation. Requests for Military Construction
Authorization will not be considered by the Congressional
Committees without this justification.
•
After determining the lowest LCC in-house and privatelyfunded alternatives, an internal rate of return (IRR)
analysis should be prepared to compare the two
alternatives. This analysis tool is used to provide
decision makers with a “business-like” evaluation tool to
assist in prioritization of projects competing for scarce
resources.
(See attachment for an IRR example case.)
A.
IN-HOUSE CONSTRUCTION ALTERNATIVES: The actual current
energy costs paid by the Government for deliveries to the
installation will be used as the starting point of all economic
analyses.
The stock fund rate charged by the Defense Fuel Supply
Center (DFSC) to facilities purchasing petroleum products under a
DFSC contract shall not be used.
Additionally, the latest official regional average,
industrial sector, energy cost escalation rates provided by the
Energy Information Administration will be used for projecting
future energy costs and developing appropriate present worth
values, as required by OMB Circular A-94. The most current
escalation rates to be used by the Services, effective January
1988, have been distributed.
B. PRIVATELY-FUNDED CONTRACTS:
Title 10 U.S.C., Section
2394 permits Military Departments to enter into long-term (up to
30 years) contracts with a private sector entity. The contract
will allow the contractor to build, own, and operate a plant to
furnish either energy or fuel to a military installation. The
House of Representatives, in its Conference Report on the 1984
Military Construction Authorization Act, stated that the Services
are to aggressively pursue private-sector financing before any
future large scale heating or power plants are authorized for
military construction funding.
In order to determine the LCC of a private-sector proposal,
only those costs and benefits that are directly associated with
the proposal should be used in the economic analysis. Although
there may be other benefits to the Government as a whole that may
reasonably be assumed to result from the proposed project (i.e.,
income taxes), these macroeconomic effects are extremely
difficult to quantify with any degree of accuracy. The use of
the OMB Circular A-94 discount rate is intended to partially
compensate for the unaccounted benefits resulting from this type
of proposal.
C. RENEWABLE ENERGY ALTERNATIVES : Title 10 U.S.C., Section
2857 requires that renewable energy alternatives shall be
selected for construction of military facilities if the
additional cost of the renewable energy system can be recovered
over the expected life of the facility. The statute further
specifies that the economic comparison shall:
(1) include all
operation and maintenance expenses expected over the life of the
facility or 15 years, whichever is shorter; (2) use a discount
rate of 7 percent per year; (3) use fossil fuel and/or other
alternative fuel costs (and a rate of cost growth for fossil fuel
costs) determined by the Secretary of Defense (These shall be the
actual costs at the installation and the latest official regional
average, industrial sector energy cost escalation rates provided
by the Energy Information Administration.); and (4) reduce the
renewable energy system investment cost by 10 percent “to reflect
an allowance for an investment cost credit.”
III.
OTHER CONSIDERATIONS:
A. POLLUTION ABATEMENT: Existing energy applications and
new projects shall comply with Federal, state, and local host
nation pollution abatement regulations, to the full extent
required by applicable laws and regulations.
B. PRIVATE SECTOR CREATIVITY:
In soliciting for privatesector projects in support of this policy, every effort should
be made to maintain flexibility in the project specification to
take maximum benefit of the creativity, technical expertise, and
inventiveness of the private sector.
C. ENERGY STORAGE :
In order to prevent mission support
disruption from fuel supply problems, Defense liquid-fueled
thermal plants will be designed to store no less than 30 days of
the maximum continuous expected demand. All coal-fired plants
shall be provided with a minimum fuel storage of 90 days such
supply. The cost of maintaining these inventories must be
considered as an “investment” when preparing the economic
analysis for these projects and all private-sector proposals must
include this provision, also. The intent of this requirement is
to ensure secure, continuous mission support capability, and
collocated or nearby fuel storage facilities may satisfy this
requirement and should be carefully considered.
Fuel shortages have in the past
D. FUEL SUBSTITUTION:
demonstrated the advantage of fuel substitution capability.
Numerous tests and extensive operating experiences have
demonstrated that successful substitute fuels are available for
diesel fuel, heating oil, and gasoline. It is important that
each installation determine those alternative fuels which can be
acceptably fired in existing equipment and what modifications are
needed to implement the substitution. Installation contingency
plans should include a fuel conversion annex detailing the
mechanical system alterations and changes in operations and
maintenance required to use alternative fuels.
ATTACHMENT
EXAMPLE
INTERNAL RATE OF RETURN CALCULATION
After the lowest life-cycle cost (LCC) in-house and
private-sector alternatives have been determined, all the
information necessary to calculate the internal rate of return
(IRR), from the Government's perspective, is available.
Utilizing the undiscounted cash flows that were used to calculate
the LCC for each project, the IRR can be determined as follows:
Investment
Cash Flow 1/
Years l-10
Private-Sector
$
$500,000
$3,072,284
Less: In-House
$1,000,000
$200,000
$2,228,913
($1,000,000)
$300,000
Difference
0
NPV 2/
@10%
IRR
27.32%
As noted in this simple example, the use of an IRR will not
change the determination of which project has the lowest LCC. It
is merely another tool to help evaluate the return the Government
can reasonably expect from "investing" its own money in a project
instead of allowing the private-sector to finance the operation.
In the above example, the Government is achieving a 27.32% return
on the taxpayers' money by undertaking this project with federal
capital. Conversely, an in-house project, such as below, that
has an IRR of less than 10% (the Government's "lost opportunity
of capital" per OMB Circular A-94) should be awarded to the
private-sector.
Investment
Cash Flow
Years 1-10
NPV 1/
@10%
Private-sector
$
$325,000
$1,996,984
Less: In
$1,000,000
$200,000
$2,228,913
($1,000,000)
$125,000
Difference
House
0
IRR
4.27%
The use of an IRR can also be used to prioritize competing
projects in a manner that may be more meaningful to a reviewer
and decision-maker than simple comparison of LCC dollars.
The actual IRR calculation can be performed on many handheld calculators or with personal computer programs by using the
cash flow data shown on the "Difference" line above.
NOTE:
1/ Undiscounted.
2/ This column represents the net present value of the cash flows
noted using a 10% discount rate.
ATTACHMENT